Succession Not Succeeding For Family Business

Wealth managers with family business owners for clients may want to prepare for some rough transitions ahead. A recent PricewaterhouseCoopers survey of more than 1,600 family-owned or managed businesses around the world found that 27 percent expect to change hands in the next five years. But 47 percent of the companies had no succession plans in place.

Wealth managers with family business owners for clients may want to prepare for some rough transitions ahead. A recent PricewaterhouseCoopers survey of more than 1,600 family-owned or managed businesses around the world found that 27 percent expect to change hands in the next five years. But 47 percent of the companies had no succession plans in place; 34 percent of companies based in North America expect to bypass their families altogether for succession, according to the report, “Kin in the Game.” Even getting a family business to the third generation can be a trial; only 15 percent of family-owned companies last past the second generation, a U.S. Trust, Bank of America Private Wealth Management study says.

Judith McGee, a financial advisor in Portland, Ore. who counsels clients with family businesses, says she is not surprised by the lack of succession planning. “We don’t like dealing with our mortality and we don’t like dealing with that particular topic. Retirement discussions and succession planning really come down to denial more than anything else,” she says. Advisors need to nudge their clients, “sometimes not so gently,” to consider the subject.

One way advisors can do that is with humor. McGee, who’s affiliated with Raymond James Financial Services, says she may tell a client, “OK, let’s do some what-if planning. You get crazy some day, and what’s next? Let’s role-play this out.’” Sometimes advisors need to perform what McGee describes as first-aid instead of surgery—getting the client to think about putting a durable power of attorney into place before moving up to more sophisticated strategies.

“The financial planner can add a lot of value by just helping clients frame what the issues are, not even taking the client to solution but helping bring the value piece in and also create a vision for the owner on what life looks like after they sell that business,” McGee says.

Randy Gerber, a financial advisor in Worthington, Oh. who specializes in working with entrepreneurs, says many clients don’t consider succession without the prodding of outside professionals such as advisors. “There’s an emotional connection to it. It’s their baby,” he says. “They don’t know how to groom talent for the next level, either. They surround themselves with people who do the jobs they can’t do, but they don’t know how to bring in professional management.”

Many entrepreneurs leave their business to their children, even if it’s not their best interests, because they don’t think to explore other options, Gerber says. Some dismiss outright the idea of selling the business to outside interests if their children are involved, he adds. He tries to get clients to identify potential buyers for their enterprises even if they expect the companies will remain within the family.

He offered one example: a $30 million distribution business run by two brothers and their best friend, all three of whom had adult children working at the company. They were “dead set” against a sale, Gerber says, but succession posed tricky issues. “There’s so many stakeholders. Each has at least one child working in the business. Everyone has a different financial situation, saver vs. spender. I didn’t know that each stakeholder’s vision of what they need personally is in line with the business,” he says. After six months, Gerber says, he was able to persuade the owners that the idea of a sale had merit.

“I had to remind them to divorce their emotions from their logic. And they get it,” he says. “And we’re in an environment where right now people are paying pretty big multiples.”

Another succession problem, particularly given the last recession and its slogging recovery, is the question of whether the parents who started the business can afford to turn it over to the next generation. Falling real estate values have thrown debt ratios out of synch at community banks, causing them to pull back on credit lines to family businesses. For families that have plowed their wealth back into their businesses, rather than paying themselves first, the timing is bad, says Glenn Ayres, a consultant and the former president of the Family Firm Institute.

If the businesses are cash-starved, there may not be enough wealth to pull out for retirement. “They didn’t balance their personal needs with the need of the enterprises,” Ayres says. “Today the scenario is, they can’t walk away until things get a whole lot better. They’re going to have to stay on the payroll. What does that do to the opportunities for the next generation?”

When an economy is struggling, the tension level in family businesses is “exponentially” higher than in other companies whose ownership is more emotionally removed from the enterprise, says Paul Karofsky, owner of Transition Consulting Group in Framingham, Mass. “In families, it’s about unconditional love, it’s about equality, it’s about everyone taking care of everyone else. In business, it’s about performance, it’s about how well we do,” Karofsky says. “When you take those two different value systems and put them together, you have fodder for instant conflict. Now add a struggling economy, and you’re really putting a lot of pepper into the mix.”

Some families may decide it’s too much trouble to pass on the business to the next generation, and they may decide to just cash out. If the business is valued at a substantial level and is owned by, say, two siblings, it may not be possible for one to buy the other out, Karofsky says. The PwC report found that 56 percent of the family businesspeople surveyed hadn’t established any procedures for buying the shares of incapacitated or deceased shareholders. And half of the respondents said they either lacked the liquidity to buy out other family members who wanted to sell their stakes, or they hadn’t considered the possibility.

One dangerous maneuver that parents sometimes perform is to bequeath the real estate on which the business rests to the children who aren’t involved in the business, while leaving the business itself to the children who are running it, Karofsky says. “What if things go poorly in the business and the brother is the landlord, and you can’t pay rent? Or the brother is struggling and wants more rent, and you don’t want to pay?” The real estate should be transitioned to the children who want to work the company, he says. Indeed, parents should think carefully about giving ownership stakes to children who aren’t involved in the business, he adds. “Putting family members who don’t work in the business in ownership positions with those who do sets them in constant judgment of those who work in the business. That is fodder for enormous conflict, and I deal with a lot of that,” Karofsky says.

So what should be done for the children who aren’t involved in the business? Karofsky says financial advisors need to stress a familiar remedy to their family business clients: diversification. Developing personal wealth outside of the company will help provide for heirs who aren’t business-minded—and also may help provide for the parents themselves if disposing of the family business becomes sticky. Gerber adds that insurance polices on the lives of the parents that name the non-business children as beneficiaries is another way to ensure that all the heirs, in and out of the family company, get a fair share of the estate.